This past week I started getting all of my tax forms. I got my W2 from the company I work for at my day job, 1099s from a variety of companies that I do freelance work for, some miscellaneous tax forms from investments that we have and reporting forms showing how much we've donated to our church and other charities.
I've been using TurboTax for the past few years, and I'll be using it again this year – so I started entering all of my information into their software a couple of nights ago (check out the tax software I recommend). I'm still waiting on a few 1099 forms, but I've almost received them all at this point.
After a couple of hours of entering data into the TurboTax interface I was shocked to realize that despite the fact that I had paid 100% of my tax liability from 2010 this past year, I was still going to end up owing quite a bit of money come tax time. In fact, it looks like I'm going to owe about $5000 in combined federal and state taxes. Wow.
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How Did I End Up Owing So Much?
How did I end up in a situation where I owe that much money on my taxes? It happened for a variety of reasons.
First, when paying my taxes using TurboTax last year it automatically calculated what my estimated tax payments for the coming year should be. It printed out payment coupons for me for what I should be paying each quarter. The total of the payments it gave me was equal to 100% of 2010's tax liability. Knowing that I would be within the safe harbor requirements for 2011 taxes, I think that gave me a false sense of assurance that despite the fact that I was tracking blog income and expenses pretty closely, I wouldn't need to do any re-calculations if my income rose – because I wouldn't be subject to any penalties. I could just pay any small overages when tax time came.
Another factor causing me to owe more than expected was the fact that my blog income rose more than I expected this year – by between $15,000-20,000. Not only that but I had another one time increase in online income due to an online asset that I sold for around $8000. So the increase in blog income, along with a one time bump due to selling that property – means I made around $25,000 more online this year than last year. I was expecting to increase income, but not quite that much – especially after I was hit by Google's Panda update last April.
Finally, the last thing that threw me off was that 2011 was the first year that we didn't have my wife's income being included in the mix come tax time. Because of that, while I expected my online income to rise, I thought it would be offset somewhat by the drop in my wife's income since she wasn't working outside the home. My online income rose so much, however, that it more than offset the drop in her income.
Making Sure To Avoid Tax Penalties
Thankfully I was able to avoid any tax penalties this year despite the fact that I underpaid my taxes by almost $5000. The reason? I met one of the criteria for the IRS safe harbor requirements. To avoid penalties you have to do one of these things:
- Owe less than $1,000 for this year’s taxes. (Nope, my taxes owed were almost $5000!)
- Withhold 100% of last year’s tax liability. (I met this requirement. Phew!)
- Withhold 90% of this year’s tax liability.
If you're not sure if you've had enough taxes withheld, you'll want to probably want to look into it and make sure. If you do need to pay more, you can just increase your withholding at your job, or increase your estimated tax payments.
Why We Can Pay A $5000 Tax Bill With No Problem
A $5000 tax bill is nothing to sneeze at, and it isn't something to be taken lightly. Thankfully we have planned ahead for unexpected expenses just like this, and have saved up a 12 month emergency fund.
One thing I did do right this year was to save a big portion of my blog earnings to completely fund that 12 month emergency fund – in addition to paying cash for our used Honda CRV. Because we planned ahead I'll be able to just transfer the funds from our Ally Bank emergency fund and pay the $5000 tax bill with no real pain to us. Of course I'll then re-fund that account over the next few months, just in case we have another crisis come up.
What can you do if you don't have the money on hand to pay the tax bill? I wrote a post about that a while back called “What Should I Do If I Can’t Pay My Taxes?”
Avoid A Big Tax Bill By Re-Evaluating Income Throughout The Year
One thing I do know after going through this is that I want to be a bit more careful next year about how much we're paying in taxes throughout the year. I don't want to have another situation crop up where we'll have to make a big lump sum payment like this.
Because of that I'm going to start the year making estimated tax payments in order to reach that 100% of last year's liability safe harbor requirement. Then I'll re-evaluate once or twice throughout the year to make sure we're paying enough to not have to owe next year (or at least not as much).
Have you ever been faced with a big tax bill at the end of the year? How did you handle it? Tell us in the comments.